I would like to think of myself as a man of science and the scientific way. That means that I follow reason and logic and maybe that is why I have really hit it off with Economics. However, back home I have found it frustrating to be a man of science. Evermore so in the field of finance and investments. As an amateur student of the Nairobi Stock Exchange, I have been puzzled by the valuations that the market places on some of the companies whose stock is traded on the Bourse. I can comfortably say that the market does not follow any fundamentals and maybe this is the reason that many companies choose not to list on the NSE. I will give a short discussion on the basics of the exchange, the meaning of fundamentals and a short analysis with a locally listed company.

In it's essence, a stock exchange is a financial intermediary. This means that it is a place where people who have money and nothing to do with it at the moment give those who do not have the money but have a use for it. It is like a bank but in this case the depositors decide who the bank will loan. When companies need capital for expansion, investment and other productive purposes, they can sell equity (part ownership) of the company to raise funds. The funds raised will be used for profit making but now the profit will be shared with the new part owners. It is a model that was started by the Dutch with the Dutch East Indian Company a very long time ago. Apart from listing, the bourse/exchange is used for investors and speculators to buy and sell the stock of a company when its underlying fundamentals change either raising or lowering its value. The trading is done with a view of making profits.

Now that I have mentioned fundamentals, I think a paragraph or two discussing this matter is deserved. Often, we hear that word and in most cases followed by a plethora of other financial jargon that confuses most investors and potential investors. Ben Graham who was the intellectual mentor of Warren Buffett reminds us that a stock is part ownership of a company and not a symbol that moves up and down a screen (ticker at the time he was discussing this). Most people think of shares as pieces of paper that people trade like cards, most people detach the share from the company and make hazard guesses on where it is going to be in the near future. What Graham posits and what is true is that when you buy a share, you become part owner of that company. I recommend that you should maybe visit the premises of the company whose shares you have bought to really internalise your position as part owner.

With this in mind, a company exhibits fundamentals when the share price reflects the value of the company. A simple example is needed here. Imagine 10 companies all growing and selling mangoes. When buying a share what would we look for? I would look at the soil fertility of each of the farms, the types of farming techniques used, the farm yields, the selling prices of each mango and the management of farms. The management is very important, imagine a farm whose management eats all the nice mangoes and sells the bad ones to us. Its management is not maximising on its profits and therefore does not offer good returns to its shareholders. The fundamentals are therefore the underlying practices and issues that pertain to the business in its efforts to maximise profits.

Now in relation to the Nairobi Stock Exchange, I state that the market does not offer any fundamentals and is driven by pure speculation and insider trading. The case of Carbacid and Safaricom are good examples. With Carbacid, after its suspension was lifted, it's share price grew phenomenally. However, on Tuesday it suffered a 37% drop and on wednesday it suffered a 7% drop. With Safaricom, speculative tendencies saw many people rush to buy only to see their investment suffer. It is the fuzzy logic that I talk about, from a simple analysis if the greater percentage of retail investors is buying in the IPO to sell shortly after the share starts trading, then wouldn't the resultant supply of shares due to the sell off depress the price and thus nullify their earlier reasoning?

The case of Jubilee Insurance can be given for this speculator syndrome. Jubilee Insurance is an insurance company that was set up in 1937. After growing in leaps and bounds it listed in 1984 on the NSE and is currently the second largest insurance in Kenya in terms of Market Share and it is the Largest in terms of operations in East Africa. Insurance companies make money from the concept of pooling of risk. When many people pay up for premiums, the insurance company through the pooling of that cash can cover some expenses as most of the people who paid the premium will not suffer any loss. Therefore they take premiums and pay up claims for losses suffered. Added to this due to the cash they make upfront from the payment of premiums, they invest this cash and earn investment income. The two main sources of earnings then for an insurance company is the underwriting profit i.e. the difference between premiums received and claims paid & Investment income.

Jubilee Insurance at the end of October was selling for around 5 times earnings, it is now selling at around 8 times earnings. This is below the market average of 13.45 times earnings. This surprises me because Jubilee has registered underwriting profits in an industry where most companies have been forced to close down. It has stayed away from motor commercial (PSV) insurance which has been the main reason for the dwindling profits of the industry. Underwriting discipline is a huge virtue in the industry and it is a good gauge of the management in place at Jubilee. The 2007 Association of Kenyan Insurers (A.K.I) report states that "Insurer's profit going forward will become increasingly dependent on investment earnings as underwriting performance steadily deteriorates". Right now very few companies have seen growth in their investments due to the global recession. However, due to the short term nature of the crisis, not too much attention should be paid to this.

The company has over the years also delivered both consistent and growing dividends that from a dividend growth perspective should see the company being valued higher than it is. Looking forward, the Kimunya Finance Bill of 2007 in reference to the Insurance industry dictates that share capital for general insurance companies should rise from KSh 100 million to Ksh 450 million. This will kick out a lot of Jubilee's competition and make the company more profitable.

The implication is that the bourse through a lack of focus on fundamentals has undervalued Jubilee Insurance and over valued a number of others. Consequently this means that you either stay out or get in with a focus on the fundamentals geared towards long term investing.